Optimize labor costs during economic challenging times

In the current economic challenging times, many companies in China are struggling with controlling costs while adhering to labor regulations. The purpose of this newsletter is to provide lawful and compliant guidance for companies to optimize labor costs effectively in different scenarios.

1.    Strategies for Controlling Labor Costs During Daily Operation

1.1    Utilization of Flexible Employment Models

Flexible employment models offer various practical approaches that can better align with dynamic business needs.

• One approach is to establish project-based labor contracts tailored for short-term projects. This way, the employment period could align with the project term. 
• Hiring part-time employees, who work less than 4 hours a day and 24 hours a week according to Article 68 of the Labor Contract Law, can also help reduce costs. Employers can terminate the employment of part-time employees without the obligation to pay compensation. Additionally, employers are not required to pay social insurances for part-time employees, except for work related injury insurance. Hiring freelancers is also a good alternative. 
• Labor outsourcing is another approach where companies contract third-party service providers to handle certain job functions or tasks instead of hiring employees directly. In this arrangement, the outsourced workers are employed by the service provider. This approach enables companies to reduce fixed costs associated with full-time employees, such as benefits, social insurance, and compensation. 
• Additionally, adjusting job descriptions in a broader way to facilitate project or position-crossed engagement allows for greater flexibility in workforce allocation, ensuring that human resources are utilized more efficiently across different roles and projects, thereby further optimizing costs. In practice, courts require that such adjustments be reasonable and fair, and that employees do not suffer any disadvantage as a result of the change.

1.2    Contract Monitoring and Clear Rules 

Effective daily labor management is crucial for reducing labor costs while maintaining legal compliance. A key aspect of this management is the proactive handling of labor contracts. We suggest that employers establish a mechanism to monitor the validity period of employees' labor contracts. If the employer decides not to renew an employee's labor contract upon expiration, it shall issue a non-extension notice before termination date to avoid constituting factual employment and penalties for not having a written contract. In addition, in areas where compensation in lieu of notice is provided, the non-extension notice shall be issued within the required time frame according to local regulations to avoid additional compensation obligations (in general 30 days in advance). Monitoring the execution of indefinite-term labour contracts is also important for companies to avoid unnecessary legal risks and penalties for failing to provide such contracts to employees who meet the required conditions.

Additionally, regularly updating the employee handbook and internal rules plays a vital role in settling disputes and maintaining workplace discipline. By clearly defining employee responsibilities and disciplinary procedures, employers can create a transparent framework that aligns with both legal standards and operational needs. Ensuring that these documents are aligned with the latest valid laws and regulations further mitigates the risk of non-compliance penalties, reducing costs associated with legal disputes or regulatory violations.

1.3    Optimization of Compensation Structures

One way to optimize the compensation structure is to divide employees’ fixed salary into a base salary and a performance-related bonus. This approach allows employers greater flexibility in labor costs by deciding each employee’s performance target and establishing a unified internal standard in the calculation of the actual commission payments.

Another approach to improving compensation structure is to implement profit-sharing plans or offer equity incentives to senior employees, which can relieve employers from the current payroll burden and enhance the employees’ motivation by aligning their interests with the employer’s success.

1.4    Reduce overtime payment 

Overtime payment could accumulate significantly over time. Implementing flexible working hours for employees with approval from the local administrative department is one solution, which allows employers to avoid paying for employees’ overtime work on weekends and regular workdays. Another solution is to regulate overtime through a clear prior application and approval procedure outlined in the employee handbook or other internal policies, which could prevent unnecessary overtime through prior review process.  

2.    Strategies for controlling labor costs in special situations

2.1    Restructuring including relocation

When restructuring leads to a change in the employer entity and the employee accepts a role with the new entity, the original employer is not required to pay severance, and the employee's years of service will be transferred to the new company. 

2.2    Redundancy

Redundancy could be executed through mutual termination or unilateral termination. In general, mutual termination shall be the first option for its ability to prevent legal disputes, maintain confidentiality, and safeguard the employer’s reputation. Mutual termination involves a severance agreement between the employer and the employee to end the employment relationship. Mandatory compensation is required by the Labor Contract Law in such cases, but employers often offer additional incentives to encourage employees’ consent. 

Unilateral termination based on mass redundancy could be considered as another option if a higher number of employees should be laid off. Mass redundancy applies to bankruptcy, business difficulties or other reasons stipulated in Article 41 of the Labor Contract Law. In these cases, specific procedural requirements shall be met, such as notifying the labor union and reporting to local labor authorities. This process can take a relatively long time, but after the above procedures are completed and labor authorities issue a receipt, courts are very likely to recognize the mass redundancy as valid, thereby deeming it a legal termination.

When neither mutual termination nor mass redundancy is possible, and the employee is not at fault, another option is unilateral termination based on circumstances changes according to Article 40(3) of the Labor Contract Law. Objective circumstances refer to external factors such as significant changes in government policy, natural disasters, or force majeure events. In practice, the actual reason for redundancy is often the elimination of a specific job position due to a restructured business plan or organizational changes. Whether this situation qualifies as an objective circumstance can vary by district and is subject to the court's discretion. Therefore, this option carries a higher risk of being deemed an illegal termination, which might result in 200% of the mandatory compensation or the continuance of the labor contract. 

Of course, employers can always refer to unilateral termination as defined in Article 39 of the Labor Contract Law if the employees are at fault or in breach of employers’ internal policies. 

Please do not hesitate to contact us if you are interested in any of these topics and we are excited to discuss it with you!

Beijing, February 11, 2025